Q&A: what is the Libor scandal and why does it matter?

Q&A: what is the Libor scandal and why does it matter?

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Pamela Yeow does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

Former Citigroup and UBS trader Tom Hayes has become the first person to be convicted for rigging global Libor interest rates. He has been found guilty of eight counts of conspiring to defraud and sentenced to 14 years in prison.

But what is Libor and what does this mean for the future of the banking industry? Pamela Yeow explains.

What is Libor?

Libor stands for the London Interbank Offered Rate. It is a global benchmark interest rate used to set a range of financial deals including how banks lend money to each other. Libor rates are calculated for five currencies and seven borrowing periods ranging from overnight to one year and are published each business day by Thomson Reuters.

It is important because it offers a reference rate for many financial instruments in both financial markets and commercial fields. Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it. For example, at least US$350 trillion in derivatives and other financial products are tied to it. It reflects the confidence banks have in each other’s financial health.

How is Libor calculated?

Each day a panel of leading banks submits the interest rates at which they are willing to lend. The highest and lowest responses are discarded and an average is taken of the middle half. Every day the average is reported at 11.30am.

How was it rigged?

It has been alleged that traders at several banks conspired to influence the final average rate – to the benefit of their trading. They would work together and submit false interest rate figures to get the desired daily rate. Tom Hayes has been found guilty of being central to this manipulation and the prosecution said he acted as one of the ringleaders.

As many as 20 major banks on all continents have been investigated including Barclays, Citibank, JP Morgan and UBS. Several have been hit with hefty fines.

What has been done about the scandal?

There has been a huge effort to crack down on the Libor scandal – and other rate-rigging that emerged in the aftermath of the financial crisis. As well as heavy fines meted out to the banks involved, the government commissioned a major review of Libor and how it was set.

Oversight of Libor moved from the British Bankers’ Association to the Intercontinental Exchange, rates are now tied more strictly to actual transactions, for which records are kept, and there are now specific criminal sanctions for manipulating the benchmark interest rates.

The first person to be convicted in the Libor scandal, Tom Hayes.EPA/Andy Rain

So should we trust the banks now?

By prosecuting Tom Hayes, the person who was seen to be the “ringleader” of the crime has been convicted. But have we regained trust in the banking system as a whole? I put forward the case that we haven’t and that it will take a lot more than just prosecuting individuals for the general public to regain their trust in the system as a whole.

When it comes to trust there are at least two levels to take into account. We might have fixed things at the individual level by removing wrongdoers from the system and setting up criminal sanctions to do so. But the system as a whole and its reputation still need repairing.

As Hayes said, he was part of a wider system of wrongdoing. The legal system has found him guilty and they may well go on to find his co-conspirators guilty. But until the organisational culture of greed, short-termism and short-sightedness is corrected, the banking sector will be far from reformed.

How can the banks regain our trust?

The bank is supposed to be a trustworthy institution where we deposit money into savings accounts and trust that it will be invested reliably. We want to be able to trust that the banking system is robust and transparent, and without fault.

Yet it’s clear that this is not the case. The Edelman Trust Barometer has found that trust in financial services has hovered around the 50% mark – only increasing from 46% in 2012 (which was when news of the Libor scandal broke) to 52% in 2015. In order to rebuild trust, Edelman found that the societal attributes of financial institutions played a more significant role than operations. For example, respondents ranked “ethical business practices” (76%), “listens to customer needs and feedback” (74%) and “places customers ahead of profits” (73%) as the three important actions financial institutions need to take in order to restore trust.

Restoring trust will be a long process. Prosecuting individuals responsible for Libor fixinng is a step in the right direction. But in the longer term, banks and financial institutions need to take ownership of the perceived faults – banking systems, regulatory systems and organisational culture. Only when they can demonstrate that they are acting in the interest of their customers, will people start to trust them again.